MiFID

The Markets in Financial Instruments Regulation (MiFIR) and Directive (MiFID II), referred to in this Guide as “MiFID”, are in application since January 2018.

While this legislative framework does not affect all private equity firms, it may have a direct or indirect impact on some private equity structures. This Guide aims to give a general overview of the different situations where MiFID is likely to apply to private equity firms and the subsequent impact of the rules on business entities covered within its scope.

The Guide is for the exclusive use of the persons to whom it is addressed and is intended for general information purposes only. It is not intended to constitute legal advice and should not be treated as such.

What are the activities covered by MiFID?

According to Article 1 of MiFID II, MiFID applies to “investment firms, market operators, data reporting services providers, and third-country firms providing investment services or performing investment activities through the establishment of a branch in the Union”.

The “investment firms” denomination covers both banks that provide investment services or perform investment activities and AIFM/UCITS managers providing MiFID II services to clients (see third section of this Guide for more details). In addition, MiFIR applies to third country firms providing investment services or performing investment activities on a cross-border basis. Investment services covered within the MiFID scope include the following (listed by order of relevance for private equity businesses): investment advice, reception and transmission of orders, placing of financial instruments without a firm commitment basis, portfolio management, execution of orders on behalf of clients, underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis.

What are the requirements imposed under MiFID?

Investment firms operating under a MiFID licence have to comply with a series of requirements in terms of product governance, transparency, conduct of business and organisational requirements. These include, where relevant and among others, rules on research and inducements, telephone taping and best execution.

Firms authorised under MiFID are also subject to prudential rules set out in the CRD/CRR framework, which may ultimately be transferred to a new framework specific to investment firms. This framework, presented by the European Commission in December 2017 and currently under discussion in the Council and the European Parliament, will introduce new capital and liquidity requirements as well as rules on public disclosure and remuneration.

I am an AIFM – do I necessary need to hold a MiFID licence?

No - private equity firms do not typically need to be authorised under MIFID II. This is because there is an exemption in Article 2(1)(i) MiFID II stating that the Directive does not apply to collective investment undertakings and the management of those undertakings. This is understood to be a reference to the principal manager, in other words the AIFM. A typical private equity fund manager (above or below the size threshold in AIFMD) of an EU or non-EU AIF will therefore be exempt from MiFID II in respect of its management of AIFs – unless it specifically provides MiFID investment services (see Question 1 for more details). Furthermore, MiFID can also have indirect implications for full-scope AIFMs.

While investment firms which only provide MiFID services are subject to MIFID II requirements in full, the following non-MiFID private equity businesses and activities may also nevertheless be subject to certain MiFID requirements depending on the interpretation made by your national competent authority:

“Advisers/arrangers”: typically affiliates of AIFMs established outside the EU (for example in the United States or the Channel Islands) whose role is to identify investment opportunities for the fund, negotiate the terms of the transaction and provide advice to the AIFM can be deemed to provide a MiFID service - see Question 5 for more details on whether these have to hold a MiFID license.

Investment advisers: managers that are not full-scope AIFMs can be deemed to provide investment advice to a third-party AIFM that is authorised to manage and market European AIFs.

Sub-investment portfolio managers: they can be authorised to provide a segregated discretionary management service under MiFID II. e.g.: certain sub-investment managers of UK Venture Capital Trusts.

Sub-entities in a private equity group (other than the manager): they can be deemed to provide MiFID services while assisting their AIFM-affiliate to raise capital for its funds. This will be similar to the way in which certain third party placement agents are authorised under MiFID.

A MiFID license is not typically required when investment services are provided within a group. However, fund managers should always carefully consider whether they benefit or not from the so-called “group exemption”.

I am an adviser/arranger – do I have to hold a MiFID license?

It depends on the country in which you are based.

In the UK, advisors/arrangers are typically authorised and regulated under MiFID. This is because the FCA takes the view: (a) that shares in private companies as well as public companies are MIFID transferable securities; (b) that arranging transactions for the fund in such securities amounts to the provision of the MiFID investment service of "reception and transmission of orders" to the fund (including within the meaning of a recital to MiFID II concerning "bringing together investors thereby bringing about transactions"); and (c) that the advisor-arranger is typically not grouped with the fund so cannot rely on the MiFID exemption for services provided exclusively intra-group.

By contrast, certain other Member States do not require a firm performing the same functions to be authorised, variously because they take the view that the group exemption does apply, or that shares in local private companies do not amount to transferable securities (but in these cases the position may be different in relation to a firm arranging transactions in publicly traded shares, for example as part of a P2P public-to-private transaction).

Can I provide MiFID activities as part of my AIFMD authorization?

Probably. Provided the laws in your home country permit it, an external AIFM can be entitled to obtain certain "top-up" MiFID permissions under Article 6(4) AIFMD. Those permissions may be used for the following services: investment advice, individual portfolio management, receipt and transmission of orders, and the safeguarding of clients financial instruments and funds.

Most aspects of MiFID, including specific capital requirements, apply to the AIFM's MiFID business, but not to its AIFM functions. In practice, this may result in the firm applying “highest common denominator” MiFID standards to the entirety of its business, given the operational challenges of applying two sets of rules. For instance, the firm may elect to apply some of the higher MiFID II best execution obligations to the whole of its activities for operational convenience, including its MiFID and non-MiFID activities.[1]

It is important to note the top up MIFID license has to be specifically applied for, as it is not granted automatically as part of the AIFM authorization process. In the UK, AIFMs with MiFID “top up” permissions are categorised as collective portfolio management investment (“CPMI”) firms by the FCA.

[1] Firms may often nevertheless choose not to apply the onerous MiFID reporting requirements to their non-MIFID business to the extent that they are not required to do so.

Can there be differences of interpretation between Member States?

Yes. In some countries (such as the UK), when a MiFID firm other than the AIFM assists the AIFM to raise capital for a fund (see Question 3 above), regulators take the view that – provided certain conditions are met – the only client of the MiFID firm (i.e. the only recipient of a service) is the AIFM. In this case, MiFID obligations to provide information to clients of the MiFID firm will not require the firm to give such information to prospective investors.

In other countries (such as France and Sweden), the act of marketing fund interests may be deemed to involve the provision of a service to the prospective investor. This may mean that the prospective investor must be advised by the marketer on the merits of the investment (although this may give rise to conflicts of interest which must be managed).

Finally, in some countries (such as in the Netherlands), national regulators have not taken any official views on this issue.

It is important to note that where services are provided across borders pursuant to MiFID passports, it is generally the view of the home Member State regulator on these points which will prevail.

Can MiFID have implications for me even if I do not have a license?

Yes. There are three potential situations:

a) MiFID can influence the way regulators apply the AIFMD

In some countries the authorities have chosen to "gold-plate" MiFID by applying certain aspects of it to full scope authorised AIFMs and/or sub-threshold AIFMs. For example, the FCA has chosen to gold-plate MiFID II by applying the following aspects to UK-authorised AIFMs, subject to certain important modifications for private equity: the telephone taping rules, the product governance rules and the inducements rules (including as they apply to the receipt by an AIFM of investment research).

Furthermore, where aspects of AIFMD and MiFID are similar to each other, there may be some interpretative read-across. For example, under AIFMD, a full scope AIFM is subject to certain rules about inducements. Under MiFID, similar inducements rules apply to a MiFID firm and extend to the receipt of gifts and entertainment by staff of the firm. This gives rise to the question: do the AIFMD inducements rules apply to gifts and entertainment received by staff of the AIFM too? The better view is that they do not.

b) MiFID requirements on other market players may ultimately have an impact on the private equity manager

A private equity firm may be affected indirectly by MiFID rules in its capacity as an AIFM. For example, where a private equity house not subject to MiFID "manufactures" a fund, a distributor of that fund subject to MiFID (such as a wealth management firm) may ask the out-of-scope manufacturer to provide certain information about the intended target market for the fund interests, and about the underlying costs of the fund, in order to facilitate compliance with MiFID rules by the distributor.

c) MiFID contains definitions that apply in an AIFMD context

Among the definitions contained in MiFID, the most important one for AIFMs is the definition of a professional investor set out in Annex II of MiFID II, which includes institutions such as banks, pension funds or insurers and any other institutional investors whose main activity is to invest in financial instruments. Furthermore, MiFID allows certain investors to become “elective” professional investors provided they satisfy a “two out of three” quantitative test based on the size of their portfolio, frequency of transactions and experience in the financial sector[1].

Investors in private equity which are not deemed professional under MiFID or have not opted in to the professional regime are categorised as retail investors under EU law. This may be the case for some family offices or high net worth individuals. This will have direct implications on private equity fund managers’ ability to market to them cross-border, as the AIFMD passport only allows fund managers to market to professional investors (Article 31 of AIFMD)

Even when marketing to retail investors is authorised by the national regulator under Article 43 of AIFMD, it will be subject to a series of additional rules (such as the production of a Key Information Document for these investors – see our Guide on KID here)

[1] Invest Europe is regularly reminding policymakers that this “elective” or “opt-in” test is inappropriate in a private equity context as they typically fail to meet the frequency criteria

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